SEPTEMBER 22' | My Site

The BAN Report: Traveling Like Its 2019 / Credit Weakens / FHLB Revamp / 2008 Under Trial / The 4MM Thundering Herd Resi Portfolio / The 40MM NNN Loan Portfolio

Traveling Like Its 2019

For the time since the pandemic, airline travel returned to 2019 levels.

Labor Day marked the first holiday travel weekend to exceed 2019 counts of airport travelers since the start of the COVID-19 pandemic, the Transportation Security Administration said.

TSA checkpoints screened 8.76 million people between Friday and Monday — 2% higher than the number recorded on Labor Day weekend in 2019, TSA spokeswoman Lisa Farbstein said on Twitter.

The American Automobile Association had forecast that one-third of Americans would travel by road, rail, or plane over the holiday weekend.

COVID-19 made a massive dent in air travel in the US and abroad after first striking in late 2019 and early 2020.

The number of total travelers dropped below 90,000 on some days in the initial months of the pandemic crisis. Travel has since rebounded — but the number of people through checkpoints remains below pre-pandemic levels on most days, according to TSA figures.

All of this is very encouraging. From looking at the travel count numbers on the TSA site, the recover in travel seems pretty consistent. For the travel industry to continue to recover, business travel needs to return to pre-pandemic levels.

Business travel, however, remains about 25% to 30% below 2019 levels, according to airlines and outfits that track sales.

And it is not clear when — or if — road warriors will return to their old travel habits.

“The whole challenge for the industry is around the return of the corporate traveler, and whether he is going to come back in enough volume and frequency that is going to help these airlines,” says John Grant, an analyst with travel-data provider OAG.

The Global Business Travel Association recently predicted that corporate travel will not fully return until mid-2026, 18 months later than the trade group had previously forecast.

The small business traveler has returned, but the large corporations are still lagging in their corporate travel. It is our view that business travel must improve, as the leisure traveler may have gotten their revenge travel out of their system.

Credit Weakens

As of today, credit is strong throughout the banking system. For example, according to the Mortgage Bankers Association, mortgage credit quality has never been better due to very low percentage of loans in delinquency and/or in foreclosure. Higher rates and a slowing economy appear to be increasing the likelihood of defaults. For example, junk bonds are seeing higher defaults.

Defaults on so-called leveraged loans hit $6 billion in August, the highest monthly total since October 2020, when pandemic shutdowns hobbled the U.S. economy, according to Fitch Ratings. The figure represents a fraction of the sprawling loan market, which doubled over the past decade to about $1.5 trillion. But more defaults are coming, analysts say.

Interest costs for an average company with debt consisting of leveraged loans have increased sharply and will likely continue to rise into next year, according to research by Barclays PLC. The percentage of loans in default will likely rise to roughly 3.25% in mid- 2023 from about 1% now, but it could go significantly higher, said Jeff Darfus, a credit analyst at the bank.

Data from a recent Fed survey of loan officers at top banks showed tightening lending standards that a Barclays’s model predicted could cause roughly 4.5% of the loans to be in default a year from now, he said.

Cineworld (Regal Cinemas) filed for Chapter 11 this week.

“As part of the Chapter 11 cases, Cineworld, with the expected support of its secured lenders, will seek to implement a de-leveraging transaction that will significantly reduce the group’s debt, strengthen its balance sheet and provide the financial strength and flexibility to accelerate, and capitalize on, Cineworld’s strategy in the cinema industry,” the second-largest movie theater chain explained. “The group Chapter 11 companies enter the Chapter 11 cases with commitments for an approximate $1.94 billion debtor-in-possession financing facility from existing lenders, which will help ensure Cineworld’s operations continue in the ordinary course while Cineworld implements its reorganization.”

The filing of a proposed plan of reorganization with the bankruptcy court would happen “in due course,” with the goal to emerge from Chapter 11 “as expeditiously as possible,” the firm said. “Cineworld currently anticipates emerging from Chapter 11 during the first quarter of 2023 and is confident that a comprehensive financial restructuring is in the best interests of the group and its stakeholders, taken as a whole, in the long term.”

The London-headquartered company operates the Regal cinemas in the U.S., as well as Cineworld and Picturehouse venues in the U.K. Overall, it operates 747 sites and 9,139 screens in ten countries.

Presumably, Regal will use the Chapter 11 process to shed itself of its unprofitable theaters, thus causing stress on these retail centers. The fact that the largest movie chains avoided BK throughout the pandemic is as much a sign of easy money as it is resiliency. We have now left the COVID-19 phase in which we propped up every single business and are now entering a normal phase. ‘

FHLB Revamp

Last week, the Federal Housing Finance Agency (FHFA) announced it was going to conduct a review of the entire FHLB system, a nearly $1 trillion network of government-chartered cooperatives that provide cheap funding for thousands of banks.

The Federal Housing Finance Agency said Wednesday that it would launch this fall a review of the structure and role of the home-loan banks, a 90-year-old system that has drawn scrutiny from current and former policy makers over whether its modern-day activities fully match its original mission of supporting mortgage lending.

The FHFA has yet to outline an overriding goal for its review, but it could lead to a push to expand the membership of the system to nonbank mortgage companies and real-estate investment trusts, potentially making the system more housing-focused after decades of what critics characterize as drift. It also opens up the possibility of the system serving purposes in addition to housing.

Founded during the Great Depression, the home-loan banks’ role has evolved. They were an important source of liquidity to commercial banks during the financial crisis of 2008. Since then, they have also become a supplier of cheap funding to some of the largest U.S. banks, in recent years including Wells Fargo & Co. and JPMorgan Chase & Co.

FHFA’s review will ensure the home-loan banks “remain positioned to meet the needs of today and tomorrow,” FHFA Director Sandra Thompson said.

This review could go in different directions. It could result in expanding membership to nonbank lenders, or a narrowing of its mission. Some have argued that the system does not do much to improve mortgage finance. Total borrowings stood at $937 billion as of July 31, so any changes could materially increase the funding costs for banks. Be prepared for a fight over this topic in the next several months!

2008 Under Trial

Bank of America, via their acquisition of Countrywide Financial, is going to trail with bond insurer Ambac in a $2.7 billion case, starting this month.

The trial before Manhattan Supreme Court Justice Robert Reed is expected to last nearly two months. Ambac claims Countrywide violated contracts governing 17 securitizations of home loans between 2004 and 2006 by flouting underwriting guidelines and passing on risks to the insurer. According to Ambac, Countrywide's leadership, including Chief Executive Angelo Mozilo, knew the majority of its mortgages were questionable but pushed employees to approve them as part of a goal to originate one out of every three home loans in the U.S.

"The company had a strategy from the top down to the bottom, and the folks on the ground were implementing this strategy to originate as many loans as they could without regard to quality and get them out as quickly as they could," Carlinsky said.

But lawyers for Countrywide said Wednesday that Ambac performed its own risk analysis when it agreed to insure the bonds for $25 million a year in premiums.

"What did Ambac know about these loans? The answer is, from the get-go, everyone, including Ambac, knew the loans in these securitizations had significant payment risks," Enu Mainigi, a lawyer for Countrywide, said in opening statements.

Ambac’s market cap is $675 million, so a $2 billion plus settlement would be a game changer. The dollar amounts are so large, it appears to be a case that can’t be settled and must be decided at trial.

The tab for Bank of America’s $4 billion purchase of Countrywide Financial in January 2008 keeps growing, making it perhaps the worst deal in the history of financial services. Bank of America has already paid out more than $50 billion to settle regulatory probes and litigation.

The 4MM Thundering Herd Resi Portfolio

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $4MM Thundering Herd Resi Portfolio.” This exclusively offered portfolio is offered for sale by one institution (“Seller”). Highlights include:

A total outstanding balance of $4,00,557 comprised of 40 loans
A weighted average coupon of 5.57%
Properties are located in three states, West Virginia (90%), Ohio (8%), and Kentucky (2%) with 74% of the portfolio within the Huntington-Ashland WV-KY-OH MSA
A weighted average maturity of 266 months (22.2 years)
75% of the loans are ARMs and the remaining are fixed
A weighted average LTV of 60%
The entire portfolio is performing

Timeline:

Sale Announcement: Thursday, September 8, 2022

Due Diligence Materials Available Online: Monday, September 12, 2022

Indicative Bid Date: Thursday, September 22, 2022

Preferred Closing Date: Friday, September 30, 2022

Please click here to view the executive summary. The confidentiality agreement is in the upper left hand corner.

The 40MM NNN Portfolio

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $40MM NNN Loan Portfolio.” This exclusively offered portfolio is offered for sale by one institution (“Seller”). Highlights include:

A total outstanding balance of $39,775,197 comprised of 13 loans
1st mortgages on retail buildings leased to credit tenants including Walgreens, CVS, and 7-Eleven
Tenant pays bank directly (“direct rent capture”)
Properties are located in 13 states across the South (62%), Midwest (20%), and West (18%)
Weighted average coupon of 4.15%
Low leverage with a weighted average LTV of 55% with all LTVs less than 63%
Weighted average seasoning of ten months and a weighted average maturity of 11.5 years; lease terms always exceed maturities
All loans have prepayment penalties
Since the program’s inception over a decade ago, the seller has never had a 30-day delinquency
Potential flow relationship of $100MM annually
Servicing-retained (preferred) or released; seller will also entertain keeping a 10% participation interest
This portfolio will trade for a premium, and any bids under par are unlikely to be entertained

Files are scanned and available in a secure deal room and organized by credit, collateral, legal, and correspondence with an Asset Summary Report, financial statements, and collateral information. Based on the information presented, a buyer should be able to complete the vast majority of their due diligence remotely.

The BAN Report: The 20MM OOCRE Loan Portfolio / Intransitory / Amtrak Strike Averted / Deposits Fall / Fed Revisiting Mergers? / The 4MM Thundering Herd Resi Portfolio

The 20MM OOCRE Loan Portfolio

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The $20MM OOCRE Loan Portfolio” This exclusively offered portfolio is offered for sale by one institution (“Seller”). Highlights include:

A total outstanding balance of $19,091,941 comprised of 13 loans in ten relationships
86% of the portfolio is comprised of a single performing loan relationship secured by 13 franchise restaurants in multiple states, four of which include 1st mortgages on the real estate
Two all-or-none pools including a Restaurant pool ($16,470,903) and a Midwest pool ($2,545,343)
The Midwest pool is primarily secured by 1st mortgages on commercial real estate, including industrial (21%), car wash (17%), retail (17%), and restaurant (15%)
98% of the portfolio is performing and 2% is sub-performing
The loans have a weighted average coupon of 6.15% and 96% of the loans are variable rate
All loans include full personal recourse

Timeline:

Sale Announcement: Thursday, September 15, 2022

Due Diligence Materials Available Online: Monday, September 19, 2022

Indicative Bid Date: Thursday, October 13, 2022

Closing Date: Thursday, November 3, 2022

Please click here to view the executive summary. The confidentiality agreement is in the upper left hand corner.

Intransitory

After a disappointing inflation report, the stock market had its worst day in over two years. Unfortunately, there is nothing transitory about inflation and it continues to persist.

U.S. consumer prices overall rose more slowly in August from a year earlier but increased sharply from the prior month after excluding volatile food and energy prices, showing that inflation pressures remained strong and stubborn.

The Labor Department on Tuesday reported its consumer-price index rose 8.3% in August from the same month a year ago, down from 8.5% in July and from 9.1% in June, which was the highest inflation rate in four decades. The CPI measures what consumers pay for goods and services.

So-called core CPI, which excludes energy and food prices, increased 6.3% in August from a year earlier, up markedly from the 5.9% rate in both June and July—a signal that broad price pressures strengthened.

On a monthly basis, the core CPI rose 0.6% in August—double July’s pace. Investors and policy makers follow core inflation closely as a reflection of broad, underlying inflation and as a predictor of future inflation.

The data suggests that inflation is tethered less to supply chain issues and Russia / Ukraine and more of a persistent problem.

Consumer Price Index data from August released on Tuesday illustrated that point. Gas prices dropped sharply last month, which many economists expected would pull overall inflation down. They also thought that recent improvements in the supply chain would moderate price increases for goods. Used car costs, a major contributor to inflation last year, are now declining.

Yet, in spite of those positive developments, quickly rising costs across a wide array of products and services helped to push prices higher on a monthly basis. Rent, furniture, meals at restaurants and visits to the dentist are all growing more expensive. Inflation climbed 8.3 percent on an annual basis and picked up by 0.1 percent from the prior month.

The data underscored that, even without extraordinary disruptions, so many products and services are now increasing in price that costs might continue ratcheting up. Core inflation, which strips out food and fuel costs to give a sense of underlying price trends, reaccelerated to 6.3 percent in August after easing to 5.9 percent in July.

“Inflation currently has a very large underlying component that is grounded in a red-hot labor market,” said Jason Furman, an economist at Harvard University. “And then, in any given month, you may get more inflation because of bad luck, like gas going up, or less because of good luck, like gas going down.”

He estimated that core inflation would continue to climb at around 4.5 percent, and rising, even if pandemic- and war-related disruptions stopped pushing prices higher.

There also seems to be some regional differences in inflation. Phoenix, for example, is seeing twice the level of inflation as San Francisco.

Inflation soared to 13% in Phoenix last month, a record for any US city in data going back 20 years and more than twice as high as San Francisco.

Other cities across the South and Southwest saw double-digit increases in consumer prices, with the Atlanta metropolitan area posting annual inflation of 11.7% and Miami reaching 10.7%, according to Bureau of Labor Statistics data.

Overall inflation was resurgent in August, dashing hopes of a nascent slowdown even as gasoline prices declined. But the national average of 8.3% masks growing disparities among cities, making the Federal Reserve’s fight against inflation more complicated.

In San Francisco, consumer prices rose 5.7% in the 12 months through August, while in Los Angeles the rate was 7.6%. In the New York city metro area, prices rose 6.6%, a slight acceleration from 6.5% in July.

The Fed is determined to combat inflation. Nomura is predicting and calling for a full one percent increase in interest rates next week – the largest increase in over 40 years. Eventually, these rate increases will work, and demand will drop, but avoiding an undisputed recession may be impossible.

Amtrak Strike Averted

The White House announced today a tentative agreement to avoid an Amtrak strike. Amtrak was scheduled to suspend all long-distance travel service today before this agreement.

President Biden said in a statement that the tentative deal “is an important win for our economy and the American people.” He credited the unions and rail companies “for negotiating in good faith and reaching a tentative agreement that will keep our critical rail system working and avoid disruption of our economy.”

The Biden administration had been holding talks with representatives from both sides to avoid transport disruptions that could have snarled supply chains, putting new pressure on prices when inflation has been hovering near four-decade highs.

Ahead of the Friday deadline, passenger-rail provider Amtrak had said it would suspend all long-distance train services starting Thursday to avoid disruptions caused by a potential strike by freight workers. While the negotiations don’t involve Amtrak workers, Amtrak’s long-distance trains operate on freight lines, and the company said it wanted to avoid passenger disruptions in the event of a strike.

Labor Secretary Marty Walsh, who had been meeting with the representatives, applauded the agreement on Twitter. “Moments ago, following more than 20 consecutive hours of negotiations at @USDOL, the rail companies and union negotiators came to a tentative agreement that balances the needs of workers, businesses, and our nation’s economy,” he wrote.

The White House statement didn’t specify details of the tentative deal. Earlier, one of the unions representing U.S. railroad workers said its members rejected a tentative agreement its leaders had reached. The International Association of Machinists and Aerospace Workers, or IAM, had said its 4,900 members had voted to reject an agreement reached with the biggest U.S. freight railroads as part of broader negotiations. A central dispute is over attendance policies and unscheduled days off if workers or their family members get sick, an IAM union official said.

With details on this tentative deal slim, it remains to be seen whether this was an actual breakthrough.

Deposits Fall

For the first time since 2018, deposits at US banks have fallen.Of course, this is after a dramatic increase in bank balance sheets due to the pandemic.

Deposits at U.S. banks fell by a record $370 billion in the second quarter, the first decline since 2018.

Deposits fell to $19.563 trillion as of June 30, down from $19.932 trillion in March, according to the Federal Deposit Insurance Corp.

The outflow in the quarter isn’t a problem for banks, which are sitting on more deposits than they want. Deposits in the banking system usually stay relatively stable but swelled by some $5 trillion in the past two years due to pandemic stimulus. Now, a series of Federal Reserve rate increases is taking some of that money out of the system, in part by decreasing demand for loans and increasing demand for government bonds.

Some analysts expect the decline in customer deposits to spur banks to hold fewer reserves at the Fed. How fast that happens will carry implications for the Fed, including when it stops tightening and the ultimate size of its balance sheet.

Complicating forecasts is a $2.2 trillion Federal Reserve Bank of New York program where investors park cash, which has held steady despite rising rates. That money is largely coming from money-market funds. The reverse repo facility swelled during the pandemic, when overloaded banks started pushing their customers to put some of their deposits in money-market funds.

Many analysts thought money would drain out of the reverse-repo facility first. But so far, the opposite has happened, and deposits declined, which could reduce bank reserves at the Fed faster than expected. That could prompt the Fed to stop tightening early next year, some economists have said.

Increasingly, banks are telling us that they are loaned up and are curbing loan originations. Some are stuck with low-yielding loan portfolios in the 3s and contemplating selling at a loss, in order to re-deploy the funds at higher yields.

Fed Revisiting Mergers?

While they are slow-walking the approval of some large bank mergers, the Federal Reserve is beginning to reconsider bank mergers by looking at both the increased risk of larger financial institutions and the impact on competition. Details at this point are light.

A once-in-a-generation review of bank merger oversight policy is gaining momentum now that the Federal Reserve's new vice chair for supervision has been seated, and senior government officials shed light on their thinking in public appearances last week.

The timing for any formal proposals remains uncertain. However, the rethink, which follows an executive order by President Joe Biden calling for a governmentwide assessment of competition policy, is already believed to have drawn out the approval process for some pending bank deals. Michael Barr, in his debut speech on Sept. 7 as the Fed's top regulator, said he would have more to say on the subject soon.

Like colleagues at other agencies, Barr said revisiting regulators' duties under the Dodd-Frank Act to weigh financial stability risks is critical. He also said the Fed will be looking at potentially tougher standards for the largest regional banks to minimize the risk they pose if they fail. Earlier this year, acting Comptroller of the Currency Michael Hsu raised the idea of extending capital and other requirements that currently apply to just eight of the biggest and most systemically important U.S. banks to large regionals and possibly conditioning merger approvals on the adoption of such standards.

Regulatory officials also said an update to competition and community impact analysis is needed because of vast changes in the financial services industry, including competition from nonbanks and complexities introduced by partnerships between banks and financial technology companies. The reconsideration could lead to a pivot away from the Herfindahl-Hirschman Index, or HHI, a relatively straightforward algorithm that has been used by regulators to assess competitive implications based on deposit market share.

As of the latest FDIC Quarterly Banking Profile, there are 4,771 banks. At the end of 2007, there were 8,559 banks. We think the Fed’s focus will likely be on the super-regional banks and preventing them from becoming “too-big-to-fail” via M&A. Will they also curtail mergers between smaller institutions due to competitive dynamics?

The 4MM Thundering Herd Resi Portfolio

A total outstanding balance of $4,000,557 comprised of 40 loans
A weighted average coupon of 5.57%
Properties are located in three states, West Virginia (90%), Ohio (8%), and Kentucky (2%) with 74% of the portfolio within the Huntington-Ashland WV-KY-OH MSA
A weighted average maturity of 266 months (22.2 years)
75% of the loans are ARMs and the remaining are fixed
A weighted average LTV of 60%
The entire portfolio is performing

Timeline:

Sale Announcement: Thursday, September 8, 2022

Due Diligence Materials Available Online: Monday, September 12, 2022

Indicative Bid Date: Thursday, September 22, 2022

Preferred Closing Date: Friday, September 30, 2022

Please click here to view the executive summary. The confidentiality agreement is in the upper left hand corner.

The BAN Report: Quarterly Banking Profile / Bank's CRE Exposure Grows / Channeling Volcker / Stuck at 3% / The 20MM OOCRE Loan Portfolio

Quarterly Banking Profile

Earlier this month, the FDIC released its Quarterly Banking Profile, the most comprehensive report on the performance of US banks. A few highlights:

The provisioning cycle has reached full circle, as banks in 2020 added to reserves, in 2021 released them, and they are adding provisions again. In Q2021, provision expenses were negative $10.8 billion; in Q2022, they were positive $11.1 billion. This is dominated by the largest banks, as the majority of institutions did not add materially to provisions in the latest quarter. Overall, quarterly net income was down 8.5% from the same quarter a year ago.
Huge increase in net interest margin, as it increased by a whopping 26 basis points from the prior quarter – the largest increase since 2010. Still, the currently 2.80% average NIM is below the pre-pandemic level of 3.2%%. As rate increases continue to cycle throughout the banking industry, NIM will continue to expand.
Loan growth was very strong, growing by over 3.5% from the prior quarter and 8.4% year over year. If you exclude PPP loans, loan growth was 11.5%. Loan growth was broad, but highest amongst consumer loans (11.6%).
As we discussed last week, deposits shrunk from the first time since 2018. With strong loan growth and deposits declines, banks are beginning to shed excess liquidity.
While the noncurrent rate stood at just 0.75%, early-stage delinquencies rose and increased by 25% from a year ago.

Overall, the banking industry is performing very well, despite not getting much love from Wall Street. We will be keeping an eye on asset quality, as we expect to see increases in delinquencies as the rate increases take effect.

Bank’s CRE Exposure Grows

As loan growth has picked up amongst banks, more banks are developing concentrations in commercial real estate by exceeding the 100% of capital threshold for construction loans and 300% of capital for CRE loans.

The number of U.S. banks that went beyond regulatory guidance on commercial real estate loan concentration rose for the fifth straight period in the second quarter and reached its highest level in five years.

The number of banks exceeding either metric rose 14.0% sequentially and 50.3% year over year in the second quarter to 505. That total is up 71.8% from a low point of 294 in the first quarter of 2021. The most recent peak in the number of banks exceeding the CRE guidance was in the first quarter of 2017, when there were 530, followed by 507 one quarter later.

According to the Mortgage Banking Association, banks have increased their share modestly in commercial and multifamily mortgages.

In the second quarter, commercial banks saw the largest gains in dollar terms in their holdings of commercial/multifamily mortgage debt – an increase of $51.9 billion (3.2 percent). REITs increased their holdings by $22.3 billion (14.4 percent), life insurance companies increased their holdings by $13.1 billion (2.1 percent), and agency and GSE portfolios and MBS increased their holdings by $8.0 billion (0.9 percent).

Banks and thrifts hold 37.8% of all commercial and multifamily mortgage debt. It is surprising the percentage isn’t higher. The rise in banks with a concentration in CRE is no cause for alarm, it just means these banks are going to find their regulators looking closer at their CRE books.

Channeling Volcker

Fed Chairman Jerome Powell is channeling former Fed Chairman Paul Volcker in making it clear that the Fed is serious about reducing inflation.

Mr. Powell cited the example of former Fed chairman Paul Volcker, who drove the economy into a deep hole in the early 1980s with punishing rate increases to break the back of double-digit price gains. “We must keep at it until the job is done,” Mr. Powell said, invoking the title of Mr. Volcker’s 2018 autobiography, “Keeping At It.”

Markets seemed to expect the Fed would act as it did in the 1970s, when under then-Chairman Arthur Burns, the central bank raised rates aggressively to bring down inflation but then reversed course prematurely for fear of inflicting more pain on the labor market than the public and Congress would tolerate.

Mr. Volcker, whose senior thesis at Princeton University criticized the Fed for allowing inflation to spike after World War II, took office determined to undo that pattern. He started his career as an economist at the New York Fed. As a Treasury official, he advised President Richard Nixon on cutting the dollar’s remaining formal ties to gold in 1971. He became president of the New York Fed in 1975, where he had a front-row seat to the Fed’s failure to tackle inflation.

After President Jimmy Carter made him Fed chair in 1979, Mr. Volcker unveiled a bold change in how the Fed would set interest rates, allowing them to rise dramatically. “Vacillation and procrastination, out of fears of recession or otherwise, would run grave risks,” he told lawmakers in early 1980. A painful double-dip recession ensued, sending unemployment to 10.8% in 1982, the highest since the Great Depression.

Mr. Powell lauds Mr. Volcker’s legacy not because of the precise tactics he used, but because “he had the courage to do what he thought was the right thing,” he said this spring at a news conference. “If you read his last autobiography, that really comes through.”

An investigation by the New York Times reviewed the old transcripts and documented how difficult the job was for the Fed. After the 1982 recession, the Fed pivoted towards loosening interest rates after inflation had come down into the 6-7 percent range.

It was, therefore, time, to shift the Fed’s focus back to interest rates, and to resolutely lower them.

This wasn’t an easy move, Mr. Kohn said, but it was the right one. “It took confidence and some subtle judgment to know when it was time to loosen conditions,” he said. “We’re not there yet today — inflation is high and it’s time to tighten now — but at some point, the Fed will have to do that again.”

The Fed pivot in 1982 had a startling payoff in financial markets.

As early as August 1982, policymakers at the central bank were discussing whether it was time to loosen financial conditions. Word trickled to traders, interest rates fell and the previously lackluster S&P 500 started to rise. It gained nearly 15 percent for the year and kept going. That was the start of a bull market that continued for 40 years.

Back in the early 80s, the independence of the Fed was unquestioned. It's not clear today that the Fed can do things as unpopular as raising rates even if it induces a recession.

Stuck at 3%

While housing inventory is up from record lows, recent data suggests that inventory will remain low as homeowners are reluctant to trade their 3%ish mortgage for a new mortgage in the 5s and 6s.

Homeowners with low mortgage rates are balking at the prospect of selling their homes to borrow at much higher rates for their next homes, a development that could limit the supply of houses for sale for years to come.

Housing inventory has risen from record lows earlier this year as more homes sit on the market longer. But the number of newly listed homes in the four weeks ended Sept. 11 fell 19% year-over-year, according to real-estate brokerage Redfin Corp. That is an indication that sellers who don’t need to sell are staying on the sidelines, economists say.

“I like to call it the ‘golden handcuffs’ of mortgage rates,” said Odeta Kushi, deputy chief economist at First American Financial Corp. “You’ve got existing homeowners who are sitting on these rock-bottom rates, and what is their financial incentive to move and lock into a rate that’s potentially as much as 3 percentage points higher than what they’ve locked into?”

Millions of Americans locked in historically low borrowing rates in recent years when the Federal Reserve kept short-term interest rates low. As of July 31, nearly nine of every 10 first-lien mortgages had an interest rate below 5% and more than two-thirds had a rate below 4%, according to mortgage-data firm Black Knight Inc. About 83% of those mortgages are 30-year fixed rates, Black Knight said.

While home sales have dropped for the seventh straight month in August, price declines are still modest.

The median existing-home price rose 7.7% in August from a year earlier to $389,500, NAR said. Prices fell month-over-month for the second straight month after reaching a record high of $413,800 in June. While prices typically decrease in the late summer, the monthly declines have been bigger than normal, said Lawrence Yun, NAR’s chief economist.

In order to induce buyers to pay 6% interest rates for a new home, there needs to be further price declines. If you can get a deal, perhaps you can refinance later the next time we have record-low interest rates. Sellers would then have to swallow a tough pill – making less than they anticipated on selling their home and trading up to a 6% mortgage.

A purchase of a home for $500K with 20% down yields a monthly payment of $2,398.20 at 6%. The monthly payment is nearly equivalent to a $570K mortgage at a 3% rate. So, a $712K home purchase results in a near equal payment as a $500K home purchase.

It remains to be seen when velocity increases in the residential housing market, but it looks like erasing some to all of the pandemic gains in home prices may be needed.

Too Many Banks Still?

As the number of banks has dropped basically in half in the last decade and a half, the American Banker wondered when the number of banks stabilizes.

"Based upon historical data and current economic and regulatory factors, I think the number would likely continue to go down for the foreseeable future," said Krista Snelling, president, and CEO of Santa Cruz County Bank in California.

"The correct number of banks is probably less than what we have today but more than what we would end up with if the industry was left to its own devices," said Jeremy Kress, an assistant professor of business law at the University of Michigan's Stephen M.

Ross School of Business.

"Now there are fewer than 1,000 banks with less than $100 million of assets. Most of those will disappear and leave us with about 3,000 banks," said Rebel Cole, a professor of finance at Florida Atlantic University.

"It's hard for me to say what the number is," said M. Terry Turner, the president and chief executive of Pinnacle Financial Partners in Nashville, Tennessee. "The number is likely in the thousands," he said. "I don't think you are going to a few hundred. How many are in places like Carthage, Tennessee, or Salisbury, North Carolina? No one else is buying those banks, and those banks are doing a good thing."

As we discussed last week, the regulators may put the brakes on consolidation, especially amongst the largest banks.

For instance, right now, "regulatory concerns have tapped the brakes on larger bank consolidation," said Bill Burgess, co-head of financial services investment banking at Piper Sandler. He described some deals that have taken a prolonged time to close, such as U.S. Bancorp's pending purchase of MUFG Union Bank, as being concerning to would-be buyers and sellers.

"If you announce a deal and it won't close for a year and you have to integrate it over two years, you better make sure it's the bank you really want to acquire," Burgess said. "It can't be your fifth choice. It better be No. 1 or No. 2."

There is currently a push to make the regulatory review process more strict, especially for those at the larger end of the spectrum. Critics noted that regulators primarily look at the Herfindahl-Hirschman Index score — a commonly used indicator of market concentration — for the combined institution's deposits and each bank's Community Reinvestment Act rating when approving mergers.

Consolidation is likely to continue, but we could be reaching a point of diminishing returns. At some point, many of the marketable banks that wish to sell will have sold. As Mr. Turner states, there are banks that are not saleable and likely to stay independent, and that is a good thing. Scale does have limits though, as evidenced by the Quarterly Banking Profile. ROA for banks over $250 billion stood at 0.92%, which was worth than every category except banks under $100 million. Banks between $10 and $250 billion had the highest ROA at 1.33%.

The 20MM OOCRE Loan Portfolio

A total outstanding balance of $19,091,941 comprised of 13 loans in ten relationships
86% of the portfolio is comprised of a single performing loan relationship secured by 13 franchise restaurants in multiple states, four of which include 1st mortgages on the real estate
Two all-or-none pools including a Restaurant pool ($16,470,903) and a Midwest pool ($2,545,343)
The Midwest pool is primarily secured by 1st mortgages on commercial real estate, including industrial (21%), car wash (17%), retail (17%), and restaurant (15%)
98% of the portfolio is performing and 2% is sub-performing
The loans have a weighted average coupon of 6.15% and 96% of the loans are variable rate
All loans include full personal recourse

Timeline:

Sale Announcement: Thursday, September 15, 2022

Due Diligence Materials Available Online: Monday, September 19, 2022

Indicative Bid Date: Thursday, October 13, 2022

Closing Date: Thursday, November 3, 2022

Please click here to view the executive summary. The confidentiality agreement is in the upper left hand corner.

The BAN Report: Home Prices Fall / Resilient Job Market / Fed Pilots Climate Change Risks / While Banks Close, Credit Unions Open / The 20MM OOCRE Loan Portfolio

Home Prices Fall

With the average 30-year fixed rate rising to 6.7%, the highest since 2007, the housing market is showing stress. This week, the Case-Shiller Index showed how home price gains reversed in July. For the first time in this cycle, the current month showed a decrease from the prior month.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 15.8% annual gain in July, down from 18.1% in the previous month. The 10-City Composite annual increase came in at 14.9%, down from 17.4% in the previous month. The 20-City Composite posted a 16.1% year-over-year gain, down from 18.7% in the previous month.

Tampa, Miami, and Dallas reported the highest year-over-year gains among the 20 cities in July. Tampa led the way with a 31.8% year-over-year price increase, followed by Miami in second with a 31.7% increase, and Dallas in third with a 24.7% increase. All 20 cities reported lower price increases in the year ending July 2022 versus the year ending June 2022.

Before seasonal adjustment, the U.S. National Index posted a -0.3% month-over-month decrease in July, while the 10-City and 20-City Composites both posted decreases of -0.8%.

After seasonal adjustment, the U.S. National Index posted a month-over-month decrease of -0.2%, and the 10-City and 20-City Composites posted decreases of -0.5% and -0.4%, respectively.

In July, only 7 cities reported increases before and after seasonal adjustments.

“Although U.S. housing prices remain substantially above their year-ago levels, July’s report reflects a forceful deceleration,” says Craig J. Lazzara, Managing Director at S&P DJI. “For example, while the National Composite Index rose by 15.8% in the 12 months ended July 2022, its year-over-year price rise in June was 18.1%. The -2.3% difference between those two monthly rates of gain is the largest deceleration in the history of the index. We saw similar patterns in our 10-City Composite (up 14.9% in July vs. 17.4% in June) and our 20-City Composite (up 16.1% in July vs. 18.7% in June). On a month-over-month basis, all three composites declined in July.

Of the 20-cities in the Index, San Francisco declined the most (3.5%), followed by Seattle (3.1%), and San Diego (2.5%). It appears the trend continued in August as Redfin came to similar conclusions.

The 10 markets cooling fastest are almost all either West Coast markets that have long been expensive, or places that became significantly less affordable during the pandemic because they attracted scores of relocating homebuyers. Las Vegas came in second place, followed by San Jose, CA, San Diego, Sacramento, CA, Denver, Phoenix, Oakland, CA, North Port, FL and Tacoma, WA.

Seattle, San Jose, San Diego, Sacramento, Denver, and Oakland are all among the 15 most expensive housing markets in the U.S. Las Vegas, San Diego, Sacramento, Phoenix and North Port are all on Redfin’s list of the 10 most popular migration destinations. That’s based on net inflow, or how many more Redfin.com users looked to move in than leave.

A 0.8% drop from June to July in the Case-Shiller seems modest when compared to a 16.1% increase from the prior year. Inventory levels remain low. To get back to pre-pandemic levels, prices would have to drop by roughly one-third. How much of the pre-pandemic gains are given back is a difficult question to answer.

Resilient Job Market

If we are in or headed towards a recession, the job market is certainly not acting like it. The Wall Street Journal wondered why the labor market remains tight despite negative GDP growth through the first half of the year.

Gross domestic product growth slipped into negative territory in the first half of the year. Borrowing costs have risen steeply as the Federal Reserve boosts interest rates in an attempt to reduce inflation. Even so, monthly payrolls have grown an average of 438,000 from January through August, nearly three times their 2019 prepandemic pace.

Many employers say they continue to struggle with large staffing shortages that built up during the pandemic and are reluctant to cut head count. In many cases, they are still hiring.

“I don’t think we’ll see mass layoffs,” said James Knightley, chief international economist at ING. “We are going to see companies prefer to hoard their labor rather than do a quick fire and then rehire because the challenges of hiring right now are incredibly intense.”

In Eau Claire, Wis., Jim Fey normally buys five to eight new buses each year for his privately owned school bus service. He doesn’t plan to purchase any in 2023 because high inflation and interest rates have put the price of a bus out of reach. He worries about a recession. “There’s going to be a lot of hurt,” he said.

Yet Mr. Fey is looking to add about 15 more school bus drivers to his staff of roughly 185. He and some of his office employees have had to drive routes since the start of this school year due to a shortage. “I can’t have my office staff out driving every single day,” he said.

Some economists say the scars of the past year’s shortages—including the huge expenses of hiring and recruiting, combined with high employee turnover—could leave companies more hesitant to lay off workers if the economy falls into a mild recession. They contend that companies never fully met their hiring needs during the recovery and that businesses will likely pull openings, which are at historic highs, before they resort to cutting jobs.

Meta Platforms, is cutting budgets and instituting a hiring freeze, but no layoffs are planned.

In what would be the first major budget cut since the founding of Facebook in 2004, Zuckerberg said the company will freeze hiring and restructure some teams to trim expenses and realign priorities. Meta will likely be smaller in 2023 than it was this year, he said.

He announced the freeze during a weekly Q&A session with employees, according to a person in attendance. He added that the company would reduce budgets across most teams, even those that are growing, and that individual teams will sort out how to handle headcount changes. That could mean not filling roles that employees depart, shifting people to other teams, or working to “manage out people who aren't succeeding,” according to remarks reviewed by Bloomberg.

If the bus company stops buying new buses and Facebook cuts their budgets, it would seem that the labor market would eventually feel the impact. But, the pandemic taught many companies how difficult it was to bring back workers after demand resumed and many will not want to repeat those mistakes.

Fed Pilots Climate Change Risks

The Federal Reserve is starting a pilot program next year, in which it will work with six of the largest banks to assess their risks to climate change.

Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo are participating in the climate scenario analysis program, the Fed said, noting that the plan is “designed to enhance the ability of supervisors and firms to measure and manage climate-related financial risks.”

The results will not trigger stricter capital or supervisory requirements for the banks, meaning there will not be a firm regulatory bite. The exercise “is exploratory in nature and does not have capital consequences,” the Fed emphasized in its announcement. It added that “scenario analysis can assist firms and supervisors in understanding how climate-related financial risks may manifest and differ from historical experience.”

The move is significant for a central bank that has often lagged behind its global peers when it comes to talking about and coming up with a plan for policing risks related to climate change. The Bank of England has already run a similar exercise.

In the analysis, financial institutions will be assessed under hypothetical climate scenarios, with the exercise starting early next year and concluding by the end of 2023. The Fed will publish “details of the climate, economic and financial variables” that are being examined at the start of the process, it said.

The banks “will analyze the impact of the scenarios on specific portfolios and business strategies,” and the board will then review those analyses. The Fed plans to publish high-level insights from the pilot program, but will not publish firm-level data.

It sounds inevitable that this pilot program will be spread throughout the banking system at some point. Banks underwrite individual credits though, generally, on past performance. When Representative Rashida Tlaib asked Jamie Dimon last week if JP Morgan Chase would stop funding new oil and gas projects, he responded “Absolutely not and that would be the road to Hell for America.” As that exchange shows, implementing climate risk analysis for banks could be fraught with challenges.

While Banks Close, Credit Unions Open

Last year, US banks shuttered a net 2,927 branches, according to S&P, thus setting a record. Credit Unions are doing the opposite and opening more branches than closing.

U.S. credit unions opened 66 branches and closed 51 in the second quarter, pushing the industry's total branch count to 19,974, according to the latest data from S&P Global Market Intelligence. By comparison, in 2021 credit unions opened 86 branches in the second quarter while closing 62.

Oregon saw four net branch openings in the second quarter of this year, the most for any state, followed by Texas and Wisconsin with three net openings each. In contrast, Georgia had the most net closures, at five, according to S&P Global.

Glenn Grau, senior vice president of sales for the Pittsburgh-based branch design firm PWCampbell, said the pandemic is still impacting branch planning for credit unions today by forcing them to continue to evaluate what the right layout and function is to serve members' changing needs.

Members who were not previously using mobile platforms had to use them for routine transactions during the pandemic, Grau said. Now, members are coming into the branch for different reasons including to deal with problems or for education, and credit unions need to adapt, Grau said.

Space Coast Credit Union in Melbourne, Florida, was among a few credit unions that added multiple branches during the second quarter, according to S&P. And the $7.3 billion-asset credit union earlier this month announced the groundbreaking for its 66th branch, which is planned for Viera, Florida.

Credit unions seem to be adding a couple branches here and there, and few are building multiple branches. Nonetheless, few are closing branches at the rate that banks did during the pandemic. Many banks are telling us that they have completed their round of branch closings and will pause to see the impact on their customers before taking any new steps to add or subtract.

The 20MM OOCRE Loan Portfolio

A total outstanding balance of $19,091,941 comprised of 13 loans in ten relationships
86% of the portfolio is comprised of a single performing loan relationship secured by 13 franchise restaurants in multiple states, four of which include 1st mortgages on the real estate
Two all-or-none pools including a Restaurant pool ($16,470,903) and a Midwest pool ($2,545,343)
The Midwest pool is primarily secured by 1st mortgages on commercial real estate, including industrial (21%), car wash (17%), retail (17%), and restaurant (15%)
98% of the portfolio is performing and 2% is sub-performing
The loans have a weighted average coupon of 6.15% and 96% of the loans are variable rate
All loans include full personal recourse

Timeline:

Sale Announcement: Thursday, September 15, 2022

Due Diligence Materials Available Online: Monday, September 19, 2022

Indicative Bid Date: Thursday, October 13, 2022

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